Edward Harrison at Naked Capitalism explains why Europe is destined for another recession in the near future. They are replicating the mistakes that led to the Great Depression being “Great:” everyone is going to cut government spending and try to increase exports in the context of a fixed currency regime. The analog between the EU now and the world in general during the Depression is as close as can be.
In order to avoid a recession — or worse — the trade deficit countries must cut back on consumption and increase exports, while the trade surplus countries need to increase consumption (either privately or through increased government spending) while decreasing exports. If this does not happen, austerity measures in the deficit countries will lead to a large decrease in GDP, make it harder to service debt and collapse demand. This in turn will make exports plummet in the trade surplus countries, bringing them into a depression as well.
The United States and China are in the same situation since China is pegging to the dollar and adjustments therefore have to be made through output instead of also being buffeted by currency movements. Michael Pettis, who has a great view on the ground, has long warned that China has continued their GDP growth by plowing into investment for export, which will come back to bite them. The US needs to cut deficits, but that must accompany a trade surplus or we too will be at risk for a depression. As long as China refuses to adjust, our hands are bound and we are going to be in a worse position. If China won’t adjust that we should decrease trade with them and have buy American provisions. [As a quick aside, Smoot-Harley wasn’t so bad for the US because trade restrictions are always that bad, it was bad because we were a major trade surplus country and we were trying to prevent adjustment in the worst way possible.] This will create a mild depression, something we should do with with open eyes, but the alternative is a far worse depression down the road.
This leads to a couple of points. Much of our trade deficit is caused by energy imports and developing domestic energy production is key to being able to right our ship around for long term prosperity. We also need to build up our manufacturing base in order to have more exports and — if our trade partners refuse to adjust — more domestic consumption. I’m going to be blunt: you cannot be pro-growth, anti-deficit and free market, not when our trading partners are refusing to allow adjustments. That is an impossibility as a decrease in deficits will lead to a collapse in growth without accompanying adjustment. The same goes for Germany. They can complain all they want about their spendthrift trading partners but the fact of the matter is that they are just as responsible for the situation as Spain, Greece, Italy, et al. This is because they have had an export driven economic model and now refuse to adjust. If things turn sour Germans share the blame as well.
The second point is that this is the real message of Keynes. Keynesian thought is not that the government should always step in to cover a demand gap that is lower than the theoretical “natural rate” (which is entirely nonsense) but that governments must take coordinated action to resolve fiscal and trade based imbalances. I am not sure why his thought has been bastardized, although post-Keynesian economists like Steve Keen argue that they are the most true to the original ideas, and it was neo-Keynesians like Paul Samuelson that corrupted the message by trying to make it overlying “scientific” and enabling governments to take the feel good message of increased spending during all downturns. Based on what I’ve read of Keynes and Keen, the latter is absolutely right in his assertion, and I have no idea how major Keynesian economists like Paul Krugman can not understand what is so explicitly stated about the importance of trade.
The final note is that this all looks so clean and tidy on paper, but readjustment is an extremely painful process. In part because of our economic ideas and in part because of human nature, we always “over optimize” our systems. This means that we embrace positive feedbacks: for example a trade deficit country can buy a lot on credit and the citizens can have more stuff, which in turn creates policies that increase the deficit, which has companies make decisions based around a consumer economy and eventually the entire economic system is built around consumption. The flip side happens for exporting countries who put off consumption but build up massive reserves that they confuse with being “wealth” (I recently posted a Pettis explanation of why this is not so). This over optimization means that too much is at stake to protect the status quo, because people become incapable of imagining how things can be different. Jobs are destroyed and investment is lost, but perhaps more importantly, psychology of the masses must completely change. This readjustment both economically and psychologically is obviously non-trivial, and even with proper economic theory, I believe that once we get as imbalanced as we are currently that it is an impossible task to rebalance without major social upheaval. However, rebalancing must occur eventually, lest it lead to complete collapse, usually through war.
In the end, we must accept that our troubles are far from over, indeed they are merely beginning. We must accept that our responses thus far have been to protect the status quo, which is making the imbalances worse, and we are quickly reaching the point where they will be too big to overcome. In the near future our banks will be too big to save. We must also accept that the debates to have are not about dollars and cents, but instead about vision and trade. It is not bad that our government is running massive deficits at the moment, a necessity due to global conditions, it is bad that the deficits are propping up a rotting model instead of building a solid foundation for a new beginning. We must also realize that in order to navigate the painful readjustment process we should focus on compassion and empathy, imagination, courage and resolve.
Musical interlude:
http://www.youtube.com/watch?v=BPDcYcjbxFETens of millions of Americans have structured their lives around the nature of the system they know, the system that must now change. This upheaval is destroying not only their security and dreams, but their entire worldview and nature of existence. This is no time for boasting or timidity: if you are fortunate enough to be well off you should actively search for ways to support the new reality and help the less fortunate. This doesn’t mean you have to support enlarging government for government is one of the worst offenders in perpetuating the imbalances, although it is highly important for keeping together the social fabric long enough to have the chance of peaceful transition. It means looking for ways to help your friends, neighbors and those that are lost in the way that best speaks to you. Increased charity, “risky” investments in emerging fields that could eventually provide millions of jobs, or even taking the “unwise” risk by jumping into a job that speaks to these aims are all admirable. I cannot count the number of times I have delivered concrete visions to highly successful and caring people, only to have them state that they fully agree with what I’m saying (often to the effect of, “This is exactly what’s needed!”) and wish that they could help, but they are too bound up in their — almost exclusively financial — obligations. They tell me to come back when I can pay them as much as they are currently making, but investors won’t give any money unless I have those types of people already on board. A deadly catch 22 that one side must have the courage to break.
We must also have the honesty to admit to ourselves that we will fail. Yes, we will fail. Our current system is unsustainable: economically, physically, psychically and spirtually. I used to be so mad at the world for not recognizing what was occurring back when it was possible to transition with relatively little disruption, and now I have come to realize that it is not only too late to have that goal, but it is human nature to play that part. I have no idea what the new system will look like, and even if it were up to one person or one group, we’d still fail because the embarking on a new path is always full of unforeseen hazards and dead ends. If we are to avoid catastrophic outcomes, we must accept that we will have great pain while groping for a new path, a process that will take a decade or two at least. As a society we’ve become so risk adverse in every facet of life, seeking to legislate, spend, invest and moralize pain and uncertainty out of the world. Regardless of ideology, false comfort in the need for certainty and hostility towards any source that tries to point out the inherent nature of reality has become the norm. But there are things worse than pain: despondency on one hand, panic on the other. Those two emotions are about to hit like a tsunami unless we change course quickly…right now the tide is still going out in subtle warning and we must not wallow in complacency until we see the wave, for then it is much too late to escape. No, the goal is not to avoid pain, which is out of our control, but to maintain dignity and resolve. Destruction and pain are not universal negatives, after all, “Shiva is depicted as “the standard of invincibility, might, and terror”, as well as a figure of honor, delight, and brilliance.”
When I talk to people that I am close with, they agree completely with this viewpoint on the intellectual level but are held captive on the emotional level out of fear of losing what they have built, both physically and socially. They know but they do not accept. I realize that it is easy for me to write this screed since I am young and have no children; I am both on the ascent in terms of my usefulness to society and do not have to worry about protecting anyone directly. I have no response to this other than that the balance of evidence suggests that inaction is leading to far worse outcomes. I’m also not encouraging everyone to drop everything in their lives (although some should because that’s who they are) and live radically different, merely to go out of their way to live by their convictions in demanding justice, compassion and courage — and to stand opposed to those that spread fear or disdain in the defense of the broken system.
I’ve noticed a common theme on TMV for quite a while, although it’s becoming much more stark. People get into heated argument full of ad hominem about how to address our problems when discussed in terms of the status quo — nearly pointless bloviating considering that the battle lines are scorched into bedrock — but when discussing visions about how society can concretely change moving forward there is much more agreement. I know I’m not the only one that’s noticed, and why are we stuck fighting old battles instead of cooperating to form a new reality? Don’t worry, once that reality is constructed then a new politics will spring up around it and we can go back to aimless but cathartic disagreement.
Anyway, at this point I have either entered or about to enter into rambling so I should stop. I’ll have more concrete talking points at another time.
Lyrics from musical interlude: Delta Spirit, People C’mon
I’m a wandering soul
I got no place of my own
Well I got nothing to give
Well I got nothing to show for it
And I’ll be wondering all, for all my years
What I become no one could knowIf you’re feeling what I’m feeling c’mon
All you soul searching people c’monAnd I got something to say my friends
I will never lay down without a fight
And when I die it will be the day
When every one of my wrongs will be made right
Only times gonna heal my pain
Lord knows the mistakes I will make
Yeah there’ll be peace on my soul someday
Reconside I’ll be on my wayAnd I’ll be wondering all, for all my years
What I become no one can sayIf you’re feeling what I’m feeling c’mon
All you soul searching people c’mon
Oh no, if you’re feeling what I’m feeling c’mon
All you soul searching people c’monAnd I’ll be wondering all, for all these years
What I become no one could know
If you’re feeling what I’m feeling c’mon
All you soul searching people c’mon